by Calculated Risk on 4/02/2007 11:29:00 PM

In the typical business cycle, non-residential investment follows residential investment. In a previous post, I presented the typical lag times for the two components of non-residential investment: 1) equipment and software, and 2) non-residential structures.

Click on graph for larger image.

The highest correlation for equipment and software is a lag of 2 to 3 quarters, and for structures a lag of 4 to 5 quarters. There is a positive correlation for other periods also.

The YoY change in residential investment turned negative in Q2 2006 (quarterly residential investment turned negative in Q4 2005).

For equipment and software, investment declined in two of the last three quarters. With a lag of 3 quarters, the YoY change would turn negative in Q1 2007. Of course the lag might be longer, or YoY investment might not turn negative this time. But it would be reasonable to expect the YoY change to turn negative soon.

So the only real surprise, in the following BusinessWeek article, is that BusinessWeek is, well, surprised!

From BusinessWeek: The Real Economic Threat: Weak Capital Spending

What's the biggest threat to the economy? The housing slump, right? After all, therein lies the greatest potential to derail consumer spending. Well, think again. Amid all the headlines about builders' woes, sagging home prices, and shaky subprime mortgages, there's some trouble brewing in another sector, perhaps more crucial to the outlook: capital spending.

And also from BusinessWeek is an article about consumers turning to credit card debt to partially offset less mortgage equity withdrawal: Borrowing Like There's No Tomorrow

Consumers are piling up credit-card debt at the fastest pace in years, and the housing downturn may be the reason. ...

The timing of the acceleration in revolving credit suggests consumers are turning to their credit cards as a partial replacement for reduced mortgage equity withdrawal ...

Kudos to dryfly for predicting this in the comments over a year ago.

by Calculated Risk on 4/02/2007 01:54:00 PM

From the WSJ: Subprime Pullback May Crimp Consumer Spending

Will it ... get harder for these consumers to buy cars, shop at the mall and dine out?

... many American families, [especially] subprime borrowers ... have been able to use the combination of rising home prices and easy credit to live beyond their means in recent years as wages have stagnated. That spending has helped to fuel the U.S. economy's growth.

... might force consumers to rein in spending, particularly lower-income Americans, who have piled up debt at a faster clip than their wealthier counterparts in the past decade. That could be a headache for the retailers, restaurateurs and others who depend on their business.

The article suggests that it will be lower-income Americans who cut back on their consumption, and the impact on the economy will be minor. However I think that a majority of MEW (Mortgage Equity Withdrawal) in recent years has been by middle income Americans, and flat or falling housing prices will also impact those borrowers. And middle income Americans will likely cut back on consumption too, even if they have no problem making their house payments.

by Calculated Risk on 4/02/2007 11:16:00 AM

Bloomberg reports: New Century Files for Bankruptcy Following Subprime Defaults

by Calculated Risk on 4/02/2007 10:44:00 AM

This is a key issue. According to the UCLA Anderson Forecast, Orange County, California (where I live) will avoid the worst of the housing bust. The logic goes something like this: Since there are very few first time buyers in O.C., there are very few subprime loans. Therefore there will be fewer homes in foreclosure, and less pressure on housing prices.

I disagree somewhat with this view. The areas with a high percentage of both housing related employment and subprime loans will most likely get hit the hardest (like California's Inland Empire). However areas like Orange County will not escape the carnage. In O.C., a large percentage of buyers used affordability products (like option ARMs) to purchase or refinance their homes. Many of these buyers will also get in trouble as housing prices stagnate and fall - it will just take a little longer than with the subprime borrowers.

Also, housing is a series of small chain reactions.

Click on graph for larger image.

Not all chain reactions start with a first time buyer using a subprime loan, but the loss of a large number of subprime buyers will impact an entire chain.

And it doesn't matter if the subprime buyer is in Orange County. The loss of a subprime buyer in Riverside means a moveup buyer can't purchase a home somewhere in Orange County.

Here is the story ...

From the O.C. Register: O.C.'s housing market to be spared worst of subprime fallout

The troubles in the subprime mortgage industry could bring stagnation to California's housing market, but Orange County should be spared the worst fallout, according to a UCLA economist.

In a report to be released today, Ryan Ratcliff, an economist with the UCLA Anderson Forecast, points out that markets with a higher proportion of first-time buyers and new homes – such as the Inland Empire and Ventura County – are seeing a bigger surge in defaults, or borrowers who fall 90 or more days behind on their mortgage payments, than areas like Orange County.
...
Orange County is "not a first-time buyer market or a market with a lot of new building," Ratcliff said in an interview. For those reasons, the recent rise in defaults is of a lesser magnitude here.
...
"Since the subprime market was almost the only thing keeping sales volume buoyant in the last years of the boom, the drying up of subprime credit suggests that home sales in California will be stagnant for some time to come," he writes.

by Anonymous on 4/02/2007 10:43:00 AM

CFC's Angelo Mozilo reminds us why letting lenders regulate themselves has worked out so well.

He said adjustable-rate mortgages and loans made without a downpayment have been used for more than a generation with proven results.

“It’s very important that we put liquidity back in the system,” Mozilo said while co-hosting "Squawk Box." “It’s important that that the Fed backs off on these guidelines and that people realize hybrids are very good loans.”

We're from the mortgage industry and we're here to help.